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Journey with DWM to
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Some economists say "up" and some say "down". The truth is, no one knows the future. But affluent, enlightened investors recognize that DWM strategies perform in up markets and protect in down markets. Regardless of what the future holds, with DWM, savvy investors are ready for what's next. | |
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Thinking, Fast and Slow: Making Better Financial Decisions
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 Making good financial decisions isn't easy. We humans don't behave the way economic models have traditionally assumed: we aren't "perfectly rational utility seekers." We suffer from biases and the ways by which our brains process information.
Nobel Prize-winning psychologist Daniel Kahneman has spent his life studying human irrationality. His latest book, Thinking, Fast and Slow, has just been published. I highly recommend it. It recaps his studies and conclusions about human nature and provides suggestions on how we can improve our financial decisions.
Try this example: A bat and a ball cost $1.10. The bat costs one dollar more than the ball. How much does the ball cost?
Probably, the first number that comes to your mind is 10 cents. But, of course, the correct answer is 5 cents. Amazingly, when Dr. Kahneman gave this puzzle to students at Harvard, MIT and Princeton, over 50% provided the wrong answer. It's not about intelligence; it's about testing and correcting, if necessary, our quick, intuitive responses.
Now, consider these two problems:
- Problem A: Which do you choose? Get $900 for sure or 90% chance to get $1,000?
- Problem B: Which do you choose? Lose $900 for sure or 90% chance to lose $1,000?
Dr. Kahneman's research showed that the great majority of people are risk averse and selected the $900 for sure in A. However, most people took the gamble in B. The sure loss is very aversive and this drives people to take the risk in B.
Our ability to make good financial decisions is distorted by biases. Loss aversion makes us too cautious and reluctant to acknowledge losses and move on. Confirmation bias leads us to seek information to validate our intuitive response or to ignore evidence that contradicts our earlier conclusions. Anchoring causes us to weigh one piece of information, which may have little relevance, too heavily in making our decisions. Recency effect causes us to give more weight to recent data. Overconfidence helps us exaggerate how well we understand the world.
We all know the K.I.S.S. principal- "Keep It Simple, Stupid." Dr. Kahneman's studies show that is exactly what our brain likes to do- keep it simple. He suggests we have two mental operations used for decision-making- System 1 and System 2. System 1 is the fast thinker, relying on intuition and is amazingly capable of misleading and being misled. System 1 produces a constant representation of the world around us and allows us to just live life. System 2 is the slow-thinker, capable of being more deliberate and rational. System 2 requires effort. Unfortunately, System 2 is also lazy. System 1, on the other hand, can't be turned off. As a result, System 1 is the "hero" of Dr. Kahneman's book, though System 2 should be, if we are to make good financial decisions.
Our world today is all about simple and quick. System 1 uses "heuristics" or rules of thumbs to speed up the process. Dr. Kahneman and Shane Frederick outlined the process in 2002. They suggested that cognitive heuristics work without conscious awareness and substitute an easier calculated heuristic attribute rather than performing a complex calculation. All of us do it every day.
Fortunately, there are some remedies for our common malady.
First, we need to acknowledge our human deficiencies. We have biases; loss aversion, confirmation, anchoring, recency, overconfidence and others. The world is complex and unpredictable. System 1 in our brain uses these biases and rules of thumb to produce quick, comfortable responses. System 2 is generally quite capable but is lazy and needs encouragement.
Second, we need to slow down and use System 2 more often. System 2 can be the skeptic if we let it. Dr. Kahneman suggests that frowning activates the skeptic within us. Just frowning, experiments show, works to reduce overconfidence and causes us to be analytical, and more vigilant in our thinking.
Third, we need appropriate third-party input on financial decisions to produce better results. Research shows that independent, informed outsiders can spot our biases easier than we can spot our own. Furthermore, advisers can provide additional information and recommendations that your System 2 can analyze in coming to its conclusions. Frankly, at DWM we see this function as one of the key roles we have as independent wealth managers for our clients- helping them make better financial decisions.
Hope your holiday season is going well. And here's to making better financial decisions in 2012. Cheers.
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Detterbeck Wealth Management
www.dwmgmt.com
220 N. Smith Street
Suite 410
Palatine, IL 60067
847.359.6262
Suite 203
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Economy: Last Week's Data
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Black Friday set new records. Consumers spent $11.4 billion, according to Shopper Trak. Foot traffic rose 5.1%. This year's 6.6% increase was the largest year over year increase since the 8.3% increase in 2007 over 2006. Online sales were up 24%. Overall, over the Thanksgiving Day weekend, sales in stores and online were $52 billion, an 8.7% increase. Unfortunately, there's less there than meets the eye. Sales started earlier, there were steep discounts, easier credit terms, free shipping, increased advertising and other services provided by retailers to push sales.
The unemployment rate went below 9% for the first time in almost three years. Employers added 120,000 jobs in November, with minor private-sector hiring off setting continued public sector cuts. The rate is now 8.6%. Unfortunately, about half of the improvement came from people dropping out of the labor force. Initial jobless claims jumped to 402,000 from 390,000 the previous week. We're not of the woods yet.
October pending home sales jumped 10.4%. The gains were led by a 24.1% rise in the Midwest and 17.7% jump in the Northeast. Contract signings were up 8.6% in the South but fell 0.3% in the West.
Manufacturing data is up. The ISM (Institute for Supply Management) index is at 52.7% in November as compared to 50.8 in October. New orders were the best since April. The November PMI (Purchasing Manager's Index) was at 62.6, up from 58.4 in October.
November vehicle sales rose to the best since the Cash for Clunkers program in August 2009.
The latest economic numbers hardly make for breakneck economic growth. More than two years after the official end to the recession, the U.S. recovery remains lukewarm at best, growing at an average rate of less than 3%. However, the economic data continues to hang in well. Even so, it is impossible to gauge what 2012 might be as Europe deals with recession and China attempts to provide a soft landing for its expected coming slowdown.
For more information: http://www.washingtonpost.com/business/did-black-friday-save-the-season-beware-the-retail-hype/2011/11/29/gIQAfNCUMO_story.html
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Europe Crisis: Time is Running Short
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Stock markets rallied last week on news that the world's major central banks had launched a joint global action to provide cheap, emergency U.S. dollars worldwide. While this initiative doesn't directly address Europe's debt or budget problems, it does help to potentially ameliorate the impact of those troubles on global markets. The Federal Reserve, the Bank of Canada, the Bank of England, the Bank of Japan, the European Central Bank and the Swiss National Bank were all parties to the statement.
It is unclear whether this action marks the prelude to even bolder actions by central banks to ease worldwide financial strains. Some analysts saw this short-term liquidity action as a positive sign that the central banks are there to support things. Others, critical of the Fed, see the move as another clear indication of the problem the euro is in.
The euro-zone partners will be meeting again next week. It is anticipated that German Chancellor Angela Merkel will be asking the 17 member nations to sign on to fiscal union and sign away their budget sovereignty. Many finance ministers want the ECB to print 2 trillion new euros and drive down the yields on the debt, similar to what the Quantitative Easing program did here in the States. So far, the ECB has purchased 200 billion euro bonds, which brought only a transitory blip in prices.
Higher stakes are hard to imagine. An EU currency breakup would certainly shake the world. The UBS Investment Research concluded that the cost of breaking up the euro is "so enormous as to be unimaginable." They suggest four likely outcomes, based on historical examples:
- Capital flight from perceived weak to perceived strong parts of the union.
- Governments use the split as an opportunity to raise revenue by seizing assets of their citizens.
- Extended bank holidays and capital controls-to stop capital flight.
- Deeply dissatisfied populations, including potential significant civil unrest.
Yesterday, Vice President Joe Biden warned that time was running out for European leaders find a solution. Nariman Behravesh, chief economist for IHS Global Insight agrees. He said that "They have to fix this in a matter of days and weeks, not months." He continued, "This is the single-biggest threat to the global economy- and to the U.S. economy."
So, what's ahead? Total bailout? Abandoning the market to chaos? Or perhaps a real fiscal union within Europe? Time will tell.
http://www.npr.org/2011/12/04/143019223/how-europes-troubles-could-become-ours-too
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| Taxes: The Uncertainty Continues | |
For the third year in a row, U.S. taxpayers head into the year-end with major tax-code issues unresolved.
Most of the really big ones expire a year from now. The "Bush" tax cuts of 2001 and 2003 expire. These had set the top tax-rate at 35% on ordinary income, 15% on capital gains and 15% on qualified dividends. In 2013, these rates would be 39.6%, 20% and 39.6%, respectively. The estate tax, which currently provides a $5 million lifetime exemption and a top tax rate of 35%, would revert as of January 1, 2013 to the 2001 version, with a $1 million per person exemption and a top rate of 55%.
In addition, in 2013, certain tax increases will take effect. There will be a 3.8% tax on net investment income for taxpayers with a joint income of $250,000 or more.
There are a number of provisions that expire in less than four weeks (12/31/11). The 2% social security payroll-tax cut or employees will fade away. The "payroll tax holiday" provided roughly $120 billion in additional income to American families in 2011. The receipt and spending of those funds in 2011 provided roughly 1% of the GDP in 2011.
The Alternative Minimum Tax ("AMT') patch enacted last year will expire. That patch was designed to reduce the number of people paying AMT to 4 million from a potential pool of 20 million in 2010.
Lastly, this is the first year that brokers must furnish the Internal Revenue Service with cost-basis information. The requirement affects securities purchased on or after January 1, 2011. Here at DWM, we have been working with Charles Schwab & Co. to scrub all cost numbers, including securities purchased before January 1, 2011.
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